Davos Doom Loses to Merkel-Draghi as Euro Defies Roubini
Dr. Doom got it wrong.
The parade of economists and investors led by Nouriel Roubini predicting Greece’s ejection by now from the euro zone failed to appreciate the resolve of European policy makers to protect their union and the amount of pain Greeks are willing to stomach.
“People underestimated these factors,” Roubini, chairman of New York-based Roubini Global Economics LLC, said in a telephone call 12 months after predicting Greece’s exit in remarks to the 2012 World Economic Forum’s annual meeting in Davos, Switzerland. A Greek departure “is certainly a less likely event this year, although not a zero probability.”
Joining him in questioning whether the 17-nation euro region was built to last and declaring Greece’s departure imminent, inevitable or in its interest were hedge-fund manager John Paulson, Goldman Sachs Group Inc. President Gary Cohn, Nobel laureates Paul Krugman and Joseph Stiglitz, Pacific Investment Management Co. Chief Executive Officer Mohamed El- Erian, Kenneth Rogoff and Martin Feldstein of Harvard University and Citigroup Inc. chief economist Willem Buiter.
Roubini -- who earned his nickname for correctly predicting the 2008 global financial crisis -- Cohn, Rogoff and Stiglitz are among the skeptics returning this week to the Alpine conference as investors pull back bets against the euro and signal the worst of the three-year debt crisis has passed.
That’s a shift in tone from a year ago, when German Chancellor Angela Merkel said Europe was “labeled the big headache of the global economy” and then-Mexican President Felipe Calderon called the continent a “time bomb.”
“I am confident that the euro zone is broadly on the right track back to financial stability and economic strength,” said Josef Ackermann, a frequent Davos attendee who stepped down last year as chief executive officer of Deutsche Bank AG, Germany’s biggest bank. “The contagion risks of Greece leaving the euro zone were too great for everyone, and European leaders are well aware that a collapse of the euro would be the end of Europe’s status as a leading force in global politics and business.”
Betting on the euro’s longevity would have made investors money last year. Those who bought junk-rated Greek bonds in January 2012 earned 78 percent, compared with 4.5 percent for German bunds, Bank of America Merrill Lynch indexes show.
The euro has gained 9 percent against the dollar since the start of August and is trading at $1.33, up from its 1999 initial value of about $1.17. The Euro Stoxx 50 Index (SX5E) is up about 11 percent from a year ago. Spain’s 10-year bond yield has fallen to 5.08 percent from a euro-era high of 7.75 percent in July. Bets made at Intrade.com now imply a 12 percent chance of a euro breakup by the end of this year, down from 54 percent a year ago.
“We are now back in a normal situation from a financial viewpoint,” European Central Bank President Mario Draghi said Jan. 10, expressing hope that “positive contagion” now will lift the economy out of recession.
The pessimists may be changing only their timing rather than their tune. While Roubini now attaches a 30 percent chance to Greece leaving in 2013, the probability increases to more than 50 percent in three to five years. Having once identified a 90 percent likelihood of a Greek exit by 2014, Citigroup economists maintain it will happen within two years as their base case.
“Politics don’t trump everything,” Roubini said. “It’s a factor, but it’s not as if it overrides everything else.”
Greece’s debt still is forecast by the European Commission to peak at 174 percent of gross domestic product this year. This -- alongside 26.8 percent unemployment, five years of recession and a fragile government -- highlights a nation in depression and at risk of backsliding on aid commitments.
“The major problem remains that Greece is unable to generate growth and jobs within the policy constraints of the euro zone,” Pimco’s El-Erian said in an e-mail. “It is also unable to obtain the type of official debt relief that is needed to lift the debt overhang. Medium-term sustainability will remain elusive.”
The euro-area economy also is hobbled by a recession and record 11.8 percent joblessness, the persistence of which could revive fears about whether governments can pay their way or of a voter backlash. Other potential sources of fresh tension include continued fiscal austerity, a bank collapse, Spain’s drawn-out debate over whether to accept the ECB’s help, a wrangle with Cyprus over aid and potential political instability from Italy’s February election.
The debate over a Greek exit easily could reignite by year- end after Germany’s election, if Greece’s coalition government wobbles or if Spain and Italy appear less at risk of contagion, says Roubini.
Rogoff, a former International Monetary Fund chief economist, said in an e-mail last week that “all the ECB’s efforts will come to naught” if governments fail to foster a true fiscal, banking and political union.
Even some Davos attendees who bet on the euro nations sticking together warn that the turmoil soon could return.
“It’s clear many people overestimated the likelihood of a Greek exit, but now the danger goes in the other direction, in that markets are too sanguine that the volatility and political noise is behind us,” said Barry Eichengreen, a professor at the University of California in Berkeley. “I do not think the period of calm will last.”
Skepticism, especially from America, long has plagued the single currency even before its existential crisis. Feldstein wrote two decades ago that “economic analysis” didn’t justify the euro -- a position he still holds. Milton Friedman, a Nobel laureate who died in 2006, said it would splinter as soon as the “global economy hits a real bump.”
“I heard a thousand times both in Europe and the rest of the world ‘the euro is about to collapse,’” said former ECB President Jean-Claude Trichet in a Jan. 5. speech to the American Economics Association in San Diego. “The euro is much more credible than what is perceived from outside.”
The dissenters became more vocal a year ago as Greece’s economy and debts failed to respond to the prescribed austerity, elections raised the prospect of a bailout-allergic Athens government and voters elsewhere chafed at rescue loans of 240 billion euros ($320 billion) for Greece.
Paulson, founder of New York-based hedge fund Paulson & Co. and manager of $19 billion, said in February that the single currency was “structurally flawed” and would eventually fall apart. He told investors last month that the bulk of his 2012 losses came on wagers that the crisis would worsen, according to a person familiar with the matter.
Pimco’s El-Erian said in May it was “probably inevitable” that Greece would leave and in August 2011 saw the potential for a “smaller, much better-integrated, fiscally strong euro zone.”
At Goldman Sachs, Cohn said last October it was “hard for me” not to think Greece would be better off outside the euro.
In academia, Krugman, a professor at Princeton University in New Jersey, wrote in a New York Times column in May entitled “Apocalypse Fairly Soon” that the euro “could fall apart with stunning speed in a matter of months, not years.” He wrote in a blog the same month that Greece could leave as soon as June.
Fellow Nobel laureate Stiglitz of New York’s Columbia University, another Davos participant, said in April that Europe was “headed to a suicide” by austerity and the most likely outcome was a core currency bloc led by Germany.
“I haven’t heard any convincing arguments that Europe will solve its problems,” Stiglitz said in Davos a year ago.
Rogoff said July 27 that Greece “ultimately” would leave the euro.
What changed the mood music is diluted demands from northern governments as the debt-stress pushed the region back into recession and threatened to engulf Spain and Italy. Merkel visited Athens in October and subsequently said she wanted Greece to stay in the euro and her countrymen should refrain from finger-pointing.
Meantime, Greek Prime Minister Antonis Samaras delivered a deeper swath of pension, wage and benefit cuts to placate creditors. For all the pain -- with a quarter of the population out of work -- pollsters Alco reported last month that 75 percent of Greeks say the country must stay in the euro.
The greater consensus unlocked a bailout deal in November: Governments agreed to cut rescue-loan interest rates, suspend interest payments for a decade and give the troubled nation more time to repay, while Greece carried out a bond buyback. Europe also made permanent its retooled rescue fund and inched toward a banking union and closer fiscal ties.
The main game changer was Draghi, who backed up a July promise to do “whatever it takes” to support the euro by detailing in September a plan to buy bonds of governments that sign up for austerity measures. As yet untapped, it’s been enough for investors to renew interest in buying Spanish and Italian debt.
“Fundamentally, what drove Europe last year was politics, not economics,” said Ian Bremmer, president of the New York- based Eurasia Group, which a year ago called the idea of a euro breakup “the single most overrated risk of 2012.”
For Klaus Schwab, the World Economic Forum’s founder and author of a new book on Europe, those who question the euro’s longevity ignore its status as the pinnacle of a five-decade postwar integration march. Southern Europe is already showing some underlying improvement with the Bank of Portugal last week predicting the first trade surplus in at least six decades.
“Last year everything was focused on Europe” at the Davos meeting, Schwab told Bloomberg Television on Jan. 16. There are still “a lot of question marks, but in general I am much more optimistic for the future compared to last year.”
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